Economics help blog – Page 164

Is the Euro really a failure or is it a failure of policy?

18 November 20172 September 2014 by Tejvan Pettinger

Readers Questions: Could you not also argue not that the Euro is a failure but that it’s members/ECB are pursuing the wrong policy? Predictions of the death of the Euro seem to have been much exaggerated & surely Europe has the potential to be a world economic superpower to rival the US or China?

It is an interesting question, and to some extent inappropriate policy is a considerable factor in the ongoing European difficulties. However, there are still structural problems surrounding the Euro, which make economic stagnation more likely than in a floating exchange rate with independent monetary policy.

Poor Policy decisions in the Eurozone

1. Failure of ECB to intervene in bond market. One example of poor policy decisions is the failure of the ECB to stop rising bond yields earlier.

In 2011 and 2012, we saw a sharp spike in bond yields – because the ECB was, at the time, unwilling to act as lender of last resort and purchase any bonds or supply liquidity. This lack of intervention by a Central Bank meant that investors became nervous and bond yields rose to very high level. This rise in bond yields caused higher debt interest payments, but most damagingly were the motivation for deep austerity which caused a deeper recession in the affected Eurozone countries.

In 2012, the ECB changed its policy and became willing to intervene in the bond market. Bond yields fell – showing that decisive Central Bank intervention was needed. Therefore, despite higher government borrowing, bond yields are now much lower than in 2011 and 2012.

Before 2012, the ECB were partly blaming the constitution of the Eurozone where it seemed the Central Bank did not have a clear mandate to intervene and provide necessary liquidity in the bond market. However, the fact that bond yields have fallen in recent months suggests that the Euro can be more successful, if the Central Bank is given the authority and mandate to provide the necessary liquidity. Some Germany bankers are still unhappy at the ECB’s intervention – fearful it may encourage fiscal profligacy.

However, it is still more difficult in the Single Currency to intervene in bond markets. It is more complicated for a European wide Central Bank – how much should it intervene? which countries should be supported ?e.t.c.

But, if the ECB had understood the necessity of intervening earlier, then we could have avoided that period of high interest rates, and partly avoided the lurch towards austerity and lower aggregate demand.

Exchange rate imbalances

A structural problem of the Eurozone is that without exchange rate fluctuations the south became uncompetitive. This led to large current account deficits in Portugal, Spain and Greece, and large current account surplus in Netherlands and Germany.

A better policy for the Eurozone would be for Germany to increase domestic demand – boost consumer spending and allow a moderately higher inflation. This would help the Eurozone to rebalance. It would lead to higher demand for southern exports and help deal with the trade imbalance in the Eurozone. It would help southern Europe restore competitiveness without just relying on deflationary policies.

Questions on monopsony

18 November 20171 September 2014 by Tejvan Pettinger

“Readers Question – A microeconomics question. In you labour market section you discuss a monopsonist.You say that “in order to employ one extra worker the firm has to increase the wages of all workers”- why? You give a coal mine as a possible example of a monopsonist, do you really think that a coal mine owner hired an extra worker(the marginal cost) and then increased the “wages of all workers”? Can you clarify this.

Just think of an upwardly sloping supply curve of labour.

If the firm offers a wage of £100, it can employ 10 workers.
To employ 11 workers, it would have to increase the wage rate to £110.

Therefore, according to this supply curve, if the firm needs to employ 11 workers the firm has to pay every worker £110. Therefore the marginal cost of employing an 11th worker is £210 (11*110 = £1,210 – 10*100). The marginal cost of the 11th worker is greater than the average cost

Theory and in practice

1. Wage discrimination. One exception would be if a monopsonist could wage discriminate – i.e. pay £110 to the extra worker, but continue to pay £100 to the existing mine workers. In reality this could be possible. For example, the firm could introduce a special post or job title which pays £110, whilst the existing workers get stuck on £100. If the monopsony can get away with this, then it will not have to pay every worker £110.

2. Elastic supply. Also, another possibility is that the supply curve is very elastic, therefore there may be infinite (or at least a very large) supply of labour at £100. For example, in a period of high unemployment, there are probably many workers willing to supply there labour at £100. Many coal mine owners may find, even at low wages, a large pool of unemployed workers willing to take a job at £100.

However, the theory of an upward sloping supply curve suggests that the marginal cost of employing an extra worker will increase faster than average cost.

Readers Question: My confusion gets worse as on the same page you say that one of the problems with a monopsonist is it can “lead to lower wages for workers”. Doesn’t this contradict your above point about a monopsonists increasing all workers’ wages as it employs one extra worker?

The key thing is that a monopsonist is reluctant to hire extra workers, precisely because it would have to increase wages of all workers (high marginal cost). Because of this prospect the monopsonist prefers to employ less workers and pay lower wages. To profit maximise, it avoids the extra marginal cost of paying all workers more.

monop

This diagram shows a theoretical monopsony. It’s profit maximising decision is to employ only Q2 workers at a wage of W2. (where MRP = MC). This is a lower wage and lower quantity of workers than in a perfectly competitive market.

See: Monopsony for more explanation

Thanks for questions – back from holiday

18 November 20171 September 2014 by Tejvan Pettinger

Thanks for the questions, which have been building up in Readers Questions During the summer holiday, I find it difficult to get into writing economics, but now the new term has started I will get back into the flow. Feel free to ask any more questions. By the way, away from economics, the highlight of …

How Much Bargaining Power Do Workers Have?

2 November 202118 July 2014 by Tejvan Pettinger

Readers Question: How much bargaining power do workers have? Bargaining Power is the ability for firms or workers to get what they want. An example of bargaining power is related to the power of trades unions. If a part-time worker works for a firm with monopsony power, they will have very low bargaining power. However, …

The economics of Hollywood

18 November 201718 June 2014 by Tejvan Pettinger

Readers question: Why does Hollywood make so many superheroes movies nowadays? What can be the economics behind it?

I’m not really a movie goer. I think the last Superhero move I watched was the original Superman back in the days when Coal miners were still a political force and people used to rent videos to watch in VHS tape players.

One reason I don’t like the usual Hollywood movies is that they are so predictable, and frankly you can get soon bored of the same formula – good guy goes down on his luck, but when things look really bleak – Superman comes back from the brink, defeats the bad guy and everyone lives happily ever after.

So, if they are so depressingly predictable, why do so many super-hero style movies get made by Hollywood?

Risk vs solid reward

Making movies is a risky business. But, ultimately studios are interested in making a profit – not in producing artistic films which may appeal to hard bitten film critics. You have to put a lot of money in, and you need to guarantee that you get a good return. With superhero style movies, they have a strong track record of getting decent revenues. If Superman 1,2,3, and 4 all made a profit. Then you could make an approximation that Superman 5 has a good chance of making profit too.

Suppose some new film director came along with a risky plot – something very independent, different, ‘artistic’ and challenging. – It could be a great success, but equally it could be a flop. You could make slightly higher than usual profits, but equally you could make a loss. Given the choice between a risky new style film and a guaranteed ‘banker’ – there is a strong economic incentive for you to choose the ‘safe’ option of another superman hero movie.

A good example, is the TV series ‘Breaking bad’ – It is critically acclaimed as one of the most innovative and well produced TV series of all times. But, when the creator approached TV networks, no one wanted to touch it. TV producers couldn’t see any track record for successful / profitable TV based on a chemistry teacher cooking crystal meth. It was very successful in the end, but the success was unexpected. Generally, TV producers would rather commission something with a more certain audience (like minor celebrities eating worms in the jungle)

Advertising and brand loyalty

One difficulty with producing films is that you have to gain strong brand loyalty in a short space of time. If nobody has heard about the subject of the film, it will be harder to attract interest. The advantage of producing a superhero movie is that there is an instant brand loyalty and awareness of the superhero like Spiderman / Superman. By using well known comic characters, you have effectively got a lot of free advertising – from the long period of customer awareness of the superhero.

The most successful film franchise – James Bond has a huge advantage because the brand of the film series is so well known. You know a James Bond film may be quite predictable, but at least you know you are going to see some good action shots, fast cars, beautiful women and spectacular backdrops.

It is one reason why books are often made into films. Awareness of the books, helps with the advertising for the film.

Does an increase in wages cause a loss of competitiveness?

6 February 202012 June 2014 by Tejvan Pettinger

Readers Question: Given the current environment, is it a valid argument of companies that increasing workers salaries will cause a loss of competitiveness? For example, cutting entry-level and middle-level workers salary while increasing management salaries will not change the profit levels of a company much. Wages are a part of a firm’s costs. If wages …

Economic reasons for long school vacations

18 November 201711 June 2014 by Tejvan Pettinger

Readers Questions: I want to know the economic reason behind:

Summer/Winter vacations in school?
or: Why we have summer/winter vacations in school.

This is an interesting question, especially as I have just finished teaching for the year and begun the long summer holidays myself.

Oxford students on their way to their last exam in May. Oxford only have 24 weeks of teaching per year.

Possible economic reasons

Non-monetary benefit for teachers. Generally, teachers pay is relatively low for the standard of their qualifications. Teachers with good degrees could probably choose a career with higher monetary benefits (and less stress) if they moved to the city or something like that. Most teachers are paid by the government, so pay is not dependent on market forces, but government’s tight budgets. Giving teachers a six week summer vacation could be seen as a non-monetary benefit to compensate for the relatively lower pay. I’ve heard some teachers say the long summer holidays are one of the best perks of the job. I’m sure if the summer holidays were just one week, there would be an even bigger rush to leave the profession, and the government would have to raise salaries to attract teachers. The government wouldn’t want to have to increase teachers pay, so it’s easier to leave the long holidays.

Education has little short term productivity. Education is not like a factory producing cars. A car factory couldn’t afford to have a six week summer break because output would immediately fall, and average costs rise (less output, less economies of scale). However, education is very different. If students take long holidays, there is going to be little change in long-term productivity of the economy. In the short term, there will be no change in the productivity of the economy. Education does not directly increase GDP. Therefore, long school holidays do not directly reduce real output.

More productive use of time. You could argue that long summer holidays are a useful opportunity for students to work in temporary summer jobs – helping the tourism industry. Summer holidays also enable teachers to work marking examination papers (I did this for a few years before I could take it no longer)

Diminishing returns from teaching longer hours. If we switched from 6 week to 2 week summer holiday – would we really get a more productive and highly educated workforce? I doubt it. Students are hard to teach by the end of May, let alone trying to teach them into mid August. Teaching students for long hours has diminishing returns. Increase the number of school weeks by 10%, may only give a 1% increase in the standards of education.

Therefore, extending the school year would have little benefit to the economy in terms of improved education standards and higher productivity.

House Price Inflation – Pros and Cons

10 September 20219 June 2014 by Tejvan Pettinger

Readers Question: Why is house price inflation considered good while other forms of inflation are considered bad? Or are all forms of inflation bad for the economy?

House price inflation has a mixed impact on the economy depending upon the extent and timing of the rise in house prices.

This graph shows house price inflation in the UK since 1981. It shows the volatility of house price inflation in the UK.

Benefits of Moderate House Price Inflation

A rise in house prices increases the wealth of householders. This can lead to increased consumer spending. Householders can take equity withdrawal from the increased value of their house.
House price inflation doesn’t reduce the value of savings like ordinary inflation. For homeowners, wealth actually increases.
House price inflation doesn’t indicate the economy is at full capacity and overheating, it just reflects demand is greater than supply in this particular market.

Problems of House Price Inflation

Rising house prices are good for homeowners, but it can reduce living standards for those who don’t have a house. In the UK house price inflation has made homes unaffordable for many first time buyers – see: House price to income ratios. Rising house prices have also had an impact on increasing rents. House prices inflation, in the UK, has increased inter generational inequality; those buying houses in the 1970s and 80s have done very well, but young people facing a very difficult housing market.

House Price Inflation and Boom and Busts

The most serious problem of house price inflation is that in booms, the rise in house prices often prove to be unsustainable. In the 1980s, rising house prices contributed to an economic boom – rising consumer spending and rapid economic growth. However, this economic growth and rise in house prices both proved unsustainable. When interest rates were increased to reduce inflation, it caused a collapse in house prices. This fall in house prices left many with negative equity. The subsequent fall in house prices was a factor in contributing to the recession of 1991. Volatility in house price inflation has a big impact on economic instability. Similarly falling house prices post 2008 (as a consequence of the overheating in house prices) has been a big drag on the US and European economies.